Determinants of Commercial Banks’ Liquidity Risk: Evidence from Ethiopia

Abstract

This paper empirically examine the determinants of liquidity risk in Ethiopian banking industry spanning the period 2005 to 2014—a period characterized by increasing the bank’s growth in different aspects. The fixed effect unbalanced panel data estimation technique was used to estimate the results without compromising the classical linear regression assumptions. The results of the analysis revealed that capital adequacy ratio, total loan to total asset ratio and total deposit to total asset ratio affects the liquidity risk of commercial banks negatively and highly statistically significantly at 0.01% significant level. These variables are found to be the most important bank specific factors that determine the liquidity position of banks. The results of the study confirms the existence of the crowding-out of deposit hypothesis in Ethiopian banking industry that could be assured by the negative and significant effect of capital adequacy.  In addition, both the share of loans and deposits in total assets and total liabilities respectively indicates mismatch of obtained funds and assets operations. All in all, the management of each bank should emphasize the importance to consider the liquidity mismatch of assets and liabilities to evaluate the liquidity profile of banks. Moreover, focusing on deposit funding leads to ignore some widely used alternative sources of funding through the issue of commercial paper enter alia, as per the recommendations of international practices.

Keywords: Determinants, liquidity risk, fixed effect, Ethiopia.